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How Risky Is Magellan Midstream Partners, L.P.?

Magellan Midstream Partners(NYSE: MMP) operates a relatively low-risk business model since the bulk of its earnings come from an extensive portfolio of fee-based pipelines and storage terminals. However, building that stable portfolio is just one of the steps the company has taken to keep risk at bay. Here's a closer look at how it stacks up against its peers and how its lower risk profile has helped the company overcome obstacles in the past so it could continue paying a growing distribution to investors.

Drilling down into the numbers

Three critical numbers for MLP investors are the percentage of cash flow underpinned by fees, the distribution coverage ratio, and the leverage ratio. Here's how Magellan Midstream Partners' metrics compare to several notable rivals:

As that chart shows, Magellan Midstream Partners has some of the most conservative metrics in its peer group. Its leverage ratio, for example, is well under 4.0 times, which is considered a safe zone for MLPs. Likewise, the company can currently cover its generous payout with room to spare since it has one of the highest coverage ratios in the group. Those two metrics, when combined with the fact that fee-based contracts underpin about 87% of its cash flow is why the company has one of the best credit ratings among MLPs, tied with Enterprise Products Partners.

That said, if there is one concern with those metrics, it's that fees only underpin 87% of cash flow, which is the lowest in the group. This factor has had an impact on the company in recent years. For example, last year distributable cash flow barely budged despite the completion of several growth projects. Meanwhile, the company was only able to reaffirm its guidance for 2017 even after securing a new contract for a recently completed project because the cash flow from that agreement would only offset the negative impact that weaker-than-expected commodity prices are having on earnings. However, with ample distribution coverage, the company has plenty of cushion to ensure that it can continue paying its distribution even if prices remain weak, which puts its payout on a much more sustainable footing than Plains All American Pipelines since it's just barely covering its distribution. Meanwhile, the company continues investing capital in building more fee-based assets that should further mute its direct exposure to commodity prices.

Image source: Getty Images.

Risk mitigation in action

Magellan Midstream Partners' numbers suggest that it shouldn't have any problem maintaining its payout even if it runs into an unexpected issue. That has certainly been the case during the recent oil market downturn since it has been able to not only maintain its payout but has joined Enterprise Products Partners as one of the few MLPs that has continued growing its distribution.

One reason Magellan has been able to do this is due to its top-notch balance sheet, which has proven to be a competitive advantage during the downturn because it has been able to access capital at a much cheaper rate than rivals. For example, Williams Partners had to offer a 7.85% interest rate to entice investors to buy the $1 billion of 10-year debt it was selling early last year when it needed cash for a looming debt maturity and to finance expansion. Meanwhile, Plains All American Pipeline had to offer an 8% yielding preferred to get the $1.5 billion it needed last year to fund expansion projects. Contrast those rates with the 5% that Magellan locked in when it offered $650 million of 10-year notes early last year so that it could refinance debt and fund growth projects.

Given their much higher capital costs, both Williams Partners and Plains All American Pipelines would go on to slash their payouts by double digits last year to shore up their financial situations. Meanwhile, because Magellan had no problem accessing the capital it needed, it was able to increase its payout by 10% last year and is on pace to grow it by 8% in 2017 and by the same rate in 2018.

Investor takeaway

Magellan Midstream Partners boasts some of the most conservative financial metrics in its peer groups. Those have proven to be a crucial advantage in recent years because they've allowed the company to overcome several obstacles. That history demonstrates to investors that Magellan is a low-risk company that has the financial strength to make it through tough times.

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